MICROECONOMICS

CHAPTER 6:
THE THEORY OF PRODUCER
BEHAVIOUR
I. FIRM

• A firm is an organization that conducts business

activities with the aim of making a profit.
• Business activities:
- Production
- Marketing
- Finance
- Human resources
- Information

2
 The firm’s goal is to maximize profit

Profit = Total Revenue – Total Cost

Π = TR – TC
(Hàm theo biến sản lượng “Q”)

3
II. THEORY OF
PRODUCTION
• Production?
• Production function?
• Production in the Short run
• MP L and APL;
• Relationship between MP Land APL
• Production in the Long run
• Production function  Optimal choice of production
• Returns to scale (Hiệu suất kinh tế theo quy mô)
1. A production process converts inputs into outputs
 Production Function

• A production function shows the relationship

between the quantity of inputs used to produce a
good and the quantity of output of that good.
Q or TP = f (K, L)

• Cobb-Douglas production function

Q or TP = A.Kα.Lβ
 Q or TP = A.Kα.Lβ

Where:
•Q or TP: output or total production
•A: technology (constant)
•K: capital
•α: output elasticity of capital
•L: labour
•β: output elasticity of labour

9
Ý nghĩa của α? Ví dụ:
α = 1,2
 Returns to scale
Hiệu suất kinh tế theo quy mô
• Increasing returns to scale (Economies of scale):
1% increase in inputs or (α+β > 1) → more than 1% increase in
outputs
or f (nK, nL) > nf(K,L)
• Constant returns to scale:
1% increase in inputs or (α+β = 1) → 1% increase in outputs
or f(nK, nL) = nf(K,L)
• Decreasing returns to scale (Diseconomies of scale):
1% increase in inputs or (α+β < 1) → less than 1% increase in
outputs
or f(nK, nL) < nf(K,L)
11
2. Production in the Short Run
• Short Run:
- at least one input is held constant/fixed
- Production in the Short Run: K is fixed input
and L is variable input.
- Production function in the Short Run:
Q or TP = f(L)

12
What do firm owners care about
production in short run (which
factor)?
• Labour (L) (because K is fixed, K is constant)
- Average Product of Labour – APL :
total product divided by the total quantity of labour
APL = (Q or TP)/L
- Marginal Product of Labour – MPL :
change in output due to an additional unit of labour
MPL = (∆Q or ∆TP)/(∆L) = (Q)’L or (TP)’L
- Relationship between MPL and APL?

13
14
15
2. Production in the Short Run

- When MPL is greater than APL, APL

is increasing.
- When MPL is less than APL, APL is
decreasing.
- When MPL is zero, TP or Q is at its
maximum.
The MPL curve crosses the APL curve
at the APL curve’s maximum.
3. Production in the Long Run
• Long Run: all inputs may become variable.
• Production function in the Long Run:
Q or TP = f(K,L)
• For example: Cobb-Douglas production function
Q or TP = A.Kα.Lβ
• Problem: Optimal choice of production?

17
 Optimization problem

• Trang trại café diện tích 5 ha, chủ trang trại đầu tư 1
khoảng chi phí hàng năm C = 500 triệu VND, đầu tư
hết cho 2 yếu tố K và L, với chi phí (giá) tương ứng r
= 300 nghìn/đơn vị và w = 200 nghìn/đơn vị. Trang
trại đang hoạt động với hàm sản xuất Cobb-Douglas
tương ứng: Q = 4K2/3L2/3. Tìm K và L để tối ưu hóa
sản xuất? (Calculate the optimal choice for capital
and labour)
 Isoquant
Đường đồng lượng
- All combinations of labour and capital
that produce the same level of output.
- Properties of isoquants:
+ Downward sloping;
+ The closer to the right
hand-side, the more output
produced;
+ Don’t cross.
 Isoquant
Đường đồng lượng

slope of the isoquant

= Marginal rate of technical

substitution (MRTS):
rate at which labour can be
substituted for capital, so that output
remains constant.
 Isoquant: Special cases
+ Perfect substitutes:
MRTS is constant at all points on isoquant.
Same output can be produced with a lot
of capital or a lot of labor or a balanced mix.

+ Perfect complements:
The output can be made with only a specific
proportion of capital and labor.
Cannot increase output unless increase both
capital and labor in that specific proportion.
 Isocost
Đường đồng phí
All combinations of L and K which cost the same.
•TC: Total cost
•L: labour
•K: capital
•w: wage rate
•r: rental rate
 Isocost
Đường đồng phí

Slope of the isocost:

Isocost
Isocost
Isocost
 Production optimization

At point C, the slope of the

isoquant curve equals the
slope of the isocost line:
Production optimization
III. THEORY OF COST

1. Definition
- Accounting costs (explicit costs)
- Opportunity costs (implicit costs)
- Economic costs = Accounting costs + Opportunity
costs
- Accounting profit = ?
- Economic profit= ?
Economic Profit vs. Accounting Profit
• Accounting profit = Total revenue - accounting costs
• Economic profit = Total revenue - economic costs
• Economic costs = Accounting costs + Opportunity costs.
2. Costs in the Short Run
• Short run:
Some inputs are fixed (e.g., factories, land).
The costs of these inputs are fixed costs (FC) which do
not vary with the amount of output.

33
2. Costs in the Short Run
2. Costs in the Short Run
Total Fixed Cost (TFC): do not vary with the quantity of
output produced
2. Costs in the Short Run
Total Variable Cost (TVC): vary with the quantity of
output produced
2. Costs in the Short Run
• Total Cost - TC:
TC = TFC + TVC
2. Costs in the Short Run

Average Fixed Cost – AFC: fixed cost divided by the

quantity of output
AFC =TFC/Q
2. Costs in the Short Run
• Average Variable Cost – AVC: variable cost divided
by the quantity of output
AVC = TVC/Q
AVC curve is U-shaped.
As output increases, AVC
falls to a minimum and then
increases.
2. Costs in the Short Run
• Average total cost - ATC: Total cost divided by the
quantity of output
ATC =TC/Q = AVC + AFC
ATC curve is U-shaped.
2. Costs in the Short Run
• Marginal cost - MC: increase in total cost from producing one
more unit
MC = TC/ Q =(TC)'Q
• Relationship between
MC and ATC, AVC?
When MC is less than AVC, AVC is decreasing.
When MC is greater than AVC, AVC is increasing.
When MC is less than ATC, ATC is decreasing.
When MC is greater than ATC, ATC is increasing.
The MC curve crosses the AVC, ATC
curve at the minimum of AVC and ATC.
2. Costs in the Short Run

Relationship between MC and ATC, AVC?

42
2. Costs in the Short Run
• Relationship between MPL and MC?
The MC is at a minimum
when the MPL is at a
maximum.
2. Costs in the Short Run
• Relationship between APL and AVC?
The AVC is at a minimum
when the APL is at a
maximum.
3. Costs in the Long Run
• Long run:
All inputs are variable (e.g., firms can build more
factories or sell existing ones).
In the long run, ATC at any Q is cost per unit using
the most efficient mix of inputs for that Q (e.g., the
factory size with the lowest ATC).

46
 EXAMPLE: LRATC with 3 factory sizes

Avg
ATCS ATCM
Firm can choose Total ATCL
from three factory Cost
sizes: S, M, L.
Each size has its own
SRATC curve.
The firm can change
to a different factory
size in the long run, Q
but not in the short
run.
 EXAMPLE: LRATC with 3 factory sizes
Avg
Total
Cost
To produce less than ATCS ATCM
QA, firm will choose ATCL
size S in the long run.
To produce between QA LRATC

and QB, firm will

choose size M
in the long run. Q
QA QB
To produce more than
QB, firm will choose
size L in the long run.
 A Typical LRATC Curve

ATC
In the real world, LRATC
factories come in
many sizes,
each with its own
SRATC curve.
So a typical
LRATC curve looks
like this: Q
 How ATC Changes as
the Scale of Production Changes

ATC
Economies of scale:
ATC falls as Q LRATC
increases.

Constant returns
to scale: ATC stays
the same as Q
increases. Q
Diseconomies of
scale: ATC rises
as Q increases.
4. Điều kiện tối đa hóa lợi nhuận của DN
Condition for profit maximization of a firm

• Profit = Total Revenue – Total Cost

•π = TR - TC
• (Hàm theo biến sản lượng “Q”)
• Để πQ max: π’Q = 0 = (TR - TC)’Q